From the June 2013 issue of Futures Magazine • Subscribe!

5 basic options strategies explained

Strangle

A strangle is the same idea as a straddle, but you purchase the call and put at different strike prices. “That’s how the butterfly and condor varied,” Burgoyne says. “Typically you’re going to be long an out-of-the-money call and an out-of-the-money put in a strangle.”

Using our $50 stock again, we buy the 45 put and the 55 call. The advantage is that by buying out-of-the-money options, our initial cost is much lower, but it also means we need to have a bigger move in the underlying for it to be profitable. If we were able to buy both the put and call for $1 each, then stock will have to reach $57 or $43 just to break even (not including commissions). “I am risking a lot less, but the chance is greater that I will lose my entire investment than with the straddle,” Kearney says.

Looking again at AAPL going into earnings, a trader could have initiated a strangle by buying the 505 put and 525 call. The move below $460 would make our put about $45 in-the-money, while our call would expire worthless.

You also are able to short a strangle, but the same issues apply as if you were to short a straddle.

With all of these strategies, you need to be aware of your positions going into expiration. If a portion of your strategy is in-the-money and you do not want to take possession, then you need to ensure you are able to exit that position before expiration.

Although these strategies allow you to balance your risk vs. reward to your liking, Burgoyne advises that traders always should consider the worst-case scenario when taking on a trade. “It all goes back to risk management. Look at that first, and proceed accordingly.”

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